Kligfeld Holdings et al. v. Commissioner; 128 T.C. No. 16 (2007) - Rhone-Poulenc v. Commissioner, 114 T.C. 533 (2000) taken to the extreme. Is this really what the Commissioner wants?

The long awaited opinion finally came out and length is an appropriate term but not in terms of pages but rather what the opinion has to say about TEFRA and the statute of limitations.

Footnote 20 of the opinion reflects the Commissioner’s views as to TEFRA and the statue of limitations as follows:

“The Court: The Kligfelds, they take the life-enhancing serum, they don't get rid of their distributed partnership property until 2100. They got the property in 1999. The IRS says inflated basis, partnership item, we're going to issue an FPAA for 1999, even though now it's January of 2100. Kosher?
IRS Counsel: Yes, I believe that is the case, your Honor”

The question is did the Court agree? The answer appears to be yes.

The facts are familiar to all those that are familiar with the son of boss cases and the Tax Court’s disdain for those shelters was evident from its rendition of the facts. The critical facts are however rather short: The Partnerships at issue filed the partnership returns as follows: Holdings 1 filed a partnership return for its brief 1999 taxable year (September 20, 1999-November 15, 1999) on July 17, 2000. Holdings 2 filed a partnership return for its short 1999 taxable year (November 15, 1999 - December 31, 1999) on July 17, 2000, The taxpayers, (the individual taxpayer) filed a joint return for 1999 on August 15, 2000, and a joint return for 2000 on April 29, 2001.

The IRS in June of 2003, issued a summons to the law firm of Jenkens & Gilchrist, which had been promoting the arrangement. The summons sought the name and address of every U.S. taxpayer who had pursued the strategy. The taxpayers were among those caught in this summons.

The IRS, in September 2004, sent Holdings 2 an FPAA for its 1999 taxable year. On the same day, the taxpayers were issued a notice of deficiency for their 2000 taxable year. Holdings 2 timely filed a petition with the Tax Court to review the FPAA, and the taxpayers timely filed a petition challenging the notice of deficiency. Taxpayer moved for summary judgment in the partnership case and argued that the Commissioner acted too slowly: the FPAA for the 1999 taxable year was issued more than three years after Holdings 2 filed its 1999 return. The IRS argued in reply that because the taxpayers' 2000 personal return reported affected items that relate back to the partnership's 1999 taxable year -- i.e., the computation of taxpayer's (and Corporation's) outside basis which then became the adjusted basis of the stock distributed and sold in 2000 -- the limitations period for making partnership adjustments was still open. The Tax Court agreed with the IRS.

Taxpayer advanced the following arguments: (1) The taxpayers relied on the fact that the FPAA was issued more than three years from the date of filing of the partnership return. The Court stated “The flaw in this argument is plain.” The Court allowed the John Doe Summons issued in June of 2003 to keep the taxpayers’ 2000 return open and then found that the summons kept the Partnerships’ 1999 returns open. The Court cited to §§ 6501 and 7609(e)(2) and found that the statue of limitations as to the individual was open. No argument as to that proposition.

But it appears that the Court found that the § 6501 and the John Doe summons kept the statute open as to the partnership return. As will be seen in (2), the question I have is where is the partnership item; affected item; partnership item at the individual partners’ level and where are these terms defined by the Court in relationship to this primary argument and how do these items related to keeping the TEFRA partnership statue open?

(2) The taxpayers argued that the IRS views section 6229 as an open ended statute under Rhone-Poulenc. To which the Court responded to the taxpayer and your point is? The Court recognized that such an open ended statute may be an extreme position in Footnote 20 but the Court was not troubled with that concept.

Observation: The problem I have with the Court’s dicta is that it is extremely broad. A reading of Rhone Poulic and the IRS’s arguments in Rhone Poulic suggest that the Court ignored certain essential terms. Terms that the Court fails to define in this opinion out of necessity or because the IRS did not define for it or the Court did not want to define. The opinion in Rhone Poulic states at 537:

Respondent argues that section 6229 does not stand alone but describes an “add on” period that, in some circumstances, extends the period prescribed by section 6501 but would never subtract from that period.

At 542:

Section 6229 provides a minimum period of time for the assessment of any tax attributable to partnership items (or affected items) notwithstanding the period provided for in section 6501, which is ordinarily the maximum period for the assessment of any tax. The section 6229 minimum period may expire before or after the section 6501 maximum period. Indeed, section 6501(n)(2) cross-references section 6229 by providing: “For extension of period in the case of partnership items (as defined in section 6231(a)(3)), see section 6229.” (Emphasis added.) (Citation Omitted).

The Court has often stated our understanding that section 6229 extends the section 6501 period with respect to tax attributable to partnership items or affected items.

At 548 - 549:

Section 6229(c)(1) deals specifically with partnership returns. It extends the period of limitations with respect to the partners if a partner, with intent to evade tax, signs or participates in the preparation of a fraudulent partnership return. Unlike section 6501(c)(1), section 6229(c)(1) applies only to tax attributable to partnership items or affected items.

As will be seen shortly, the main problem I have with the Court’s opinion is that it ignores the plain language of the statute – partnership returns, partnership items and affected items. The Court fails to define these terms and relate these statutory terms to any of its holding. Rather, the opinion appears to assume that the reader can easily discern the partnership item or the affected item at issue. More importantly how that undefined item keeps the TEFRA statute open. As will be seen later, the Tax Court has struggled mightily with these terms in the past yet for reasons unknown it skips over these essential terms to reach a conclusion. In light of Hinck v. United States, 127 S. Ct. 2011 (2007) and EC Term of Years Trust v. United States, - U.S. - (2007), I wonder if such analysis will go unchallenged.

(3) The Court dismissed the petitioner’s following argument: “section 706(a), which states as a general rule that a partner's inclusion of income, loss, deductions, etc., with respect to a partnership shall be based on the income, gain, loss, deduction, or credit of the partnership for any taxable year of the partnership ending within or with the taxable year of the partner." (Emphasis added.) He then applies this rule to the "principle of fixed, periodic accountings" and draws the conclusion that a "statute of limitations for assessment of tax liability" makes sense only when there is an "interlacing of partners' and partnerships' taxable years."

The Court dismissed the argument as overreaching without saying much more other than to say Section 706 does not define all partnership or affected items. Query to the Court then why not cite the regulations that do define partnership and affected items and relate these terms to the opinion at hand. See Treas. Reg. §301.6231.

(4) Petitioners asked the Court to focus on the following language from section 6226(d)(1)(B), pointing out that it says that a partner may not be a party to a TEFRA proceeding after the day on which "the period within which any tax attributable to such partnership items may be assessed against that partner expired." The phrase "such partnership items" refers to subsection (d)(1)(A), which discusses "the partnership items of such partner for the partnership taxable year * * *."

The Court submitted that said language was not the relevant language but rather “the key language in section 6226(d)(1)(B) is that a partner may be a party to the TEFRA procedure for the period within which "any tax attributable to such partnership items" can be assessed.” The Court then stated “the potential resulting tax was attributable -- in the sense of being at least partially dependent on -- that basis computation.”

The Court then stated “the assessment of tax with the adjustment of partnership items. Section 6229(a) -- the key section in this case -- does refer to the partnership's taxable year, but only in reference to assessment of tax and not to adjustment of partnership items. . . Since section 6229(a) modifies section 6501, and section 6501 sets a three-year general limitation period for assessments, we read the difference in language between the two TEFRA provisions to indicate that Congress anticipated that the taxable year in which an assessment is made would not always be the same as the taxable year in which the adjustments are made. ”

It appears then that the Court found that basis computation is an affected item and according to the Cout maybe even a partnership item. See Trea.Reg. §301.6231(a)(5)-1(b). ["basis in a partner's partnership interest - The basis of a partner's partnership interest is an affected item to the extent it is not a partnership item"]. Thus, any impact to basis, be it outside or inside according to this Court, may be an affected/ partnership item. The problem with said analysis is that Basis Computation as a partnership/affected item that requires the TEFRA partnership to remain open has not been a consistent position advocated by the IRS or a position of the Tax Court or the regulations.

The IRS is generally prohibited from assessing a deficiency regarding a partnership item without first making the appropriate adjustments to the partnership items in a partnership level proceeding. I.R.C. § 6225(a). The IRS, however, may adjust non-partnership items, including affected items, under the existing deficiency procedures. See Jenkins v. Commissioner, 102 T.C. 550 (1994); Gustin v. Commissioner, T.C. Memo. 2002-64.

I.R.C. § 6231(a)(3) defines a "partnership item" as any item that is required to be taken into account for the partnership's taxable year under any provision of the Code to the extent that Service regulations provide that the item is more appropriately determined at the partnership level than at the partner level. N.C.F. Energy Partners v. Commissioner, 89 T.C. 741 (1987). Treasury regulations define partnership items to include "the partnership's aggregate and each partner's share of . . . [i]tems of income, gain, loss, deduction or credit of the partnership." Treas. Reg. section 301.6231(a)(3)-1(a)(1). Partnership items also include factors affecting the determination of other partnership items. Treas. Reg. section 301.6231(a)(3)-1(b). Thus, the determination of "each partner's share" of a partnership's income, gain, loss, deductions or credits is a partnership item that can only be adjusted in a partnership proceeding. See Hambrose Leasing 1984-5 Limited Partnership v. Commissioner, 99 T.C. 298 (1992) (allocating partners' share of losses).

An affected item is any item on a partner's return to the extent that it is affected by a partnership item. I.R.C. § 6231(a)(5); Jenkins v. Commissioner, 102 T.C. 550, 554 (1994). Affected items can be either computational adjustments (which the IRS can make to reflect the adjustment of partnership items without issuing a notice of deficiency), I.R.C. § 6231(a)(6), or items that require a factual determination at the individual partner level (using the deficiency procedures). See N.C.F. Energy Partners v. Commissioner, 89 T.C. 741 (1987). Either type of affected item may be determined only after the partnership items or items upon which it is based are established.

By definition, affected items are not partnership items; thus, they are not subject to determination at the partnership level. I.R.C. § 6230(a)(2)(a)(i) authorizes respondent to issue a notice of deficiency for affected times that require partner level determinations. Further, if the IRS is not contesting the partnership items as reported by the partnership, the IRS is not required to conduct an examination of the partnership returns before issuing a notice of deficiency to contest an affected item. See Jenkins v. Commissioner, 102 T.C. 550, 566 (1994); Roberts v. Commissioner, 94 T.C. 853 (1990); Gustin v. Commissioner, T.C. Memo. 2002-64.

In Gustin v. Commissioner, T.C. Memo. 2002-64 the taxpayers claimed losses from a TEFRA partnerships. Respondent did not conduct a TEFRA audit of the partnership and the statute of limitations expired without any partnership level adjustments being made. Respondent issued a notice of deficiency to the taxpayer limiting the losses to their bases in the partnerships. The Court held that a determination of a taxpayer's basis was an affected item not a partnership item subject to TEFRA procedures. The court stated:

A partner's basis in his partnership interest is an affected item. Sec. 301.6231(a)(5)-1T(b), Temporary Proced. & Admin. Regs. 6790 (Mar. 5, 1987). Our normal deficiency procedures apply to "any deficiency attributable to *** affected items which require partner level determinations. Sec. 6230(a)(2)(A)(i). Since a partner's basis in a partnership interest may require determination at the partner level, deficiencies attributable to adjustments to basis must be made at the partner level. See Dial USA, Inc. v. Commissioner, 95 T.C. 1, 5-6 (1990).

In Dial USA, Inc. v. Commissioner, 95 T.C. 1(1990), the issue was whether the TEFRA provisions controlled. The case involved a Subchapter S corporation. The court noted that the critical factor as to whether TEFRA applies is not where "whether a particular item is determinable by information actually available at the corporate level . . . Instead the critical factor is whether the corporation was required to make the determination." The court then noted that an example of such a non-TEFRA item "would be where one shareholder purchases stock from another shareholder. In that situation, the purchase price of the stock would increase the shareholder's basis; however, there is no requirement that the purchase price be taken into account for the taxable year of the S corporation." At footnote 4 the court stated: "The same situation can exist with respect to the basis of a partner in a partnership".

Thus, the acquisition of the partnership interest from another partner is an affected item not a partnership item. Support for this judicial proposition is also found in respondent's regulations. Proced. & Admin. Regs. § 301.6231(a)(3)-1(c)(3)(iv) states that:

To the extent that that determination requires other information, however, that item is not a partnership item. Such other information would include those factors used in determining the partner's basis for the partnership interest that are not themselves partnership items, such as the amount that the partner paid to acquire the partnership interest from a transferor partner if that transfer was not covered by an election under section 754. (Emphasis Added).

So the question that I have for the Court and the IRS is simple what is the partnership item, what is the affected item and how do these items interrelate in Kligfeld to keep the statue open as to the TEFRA partnership not the taxpayer’s individual return?

Just as important, if I were the IRS, the next time a notice of deficency is sent and the TEFRA partnership statute has expired be prepared for Kigfeld to be used as a sword.

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